Throughout the world, proactive risk managers develop measures to prevent, minimise, or manage the negative effects of risk on their organisations. Extant research affirms the existence of various ways in which companies could effectively manage risk. The strategy adapted by companies to avert the occurrence of risk is largely influenced by careful analyses of the costs and benefits of possible alternatives. The analyses would usually include:
Identification of organisational risks: The first step in the risk management process is the identification of risks saddled with the unit of analysis, that is, corporate organisation. This enables the risk manager to determine the appropriate technique or techniques to be adopted to effectively remedy the situation. For instance, if a preliminary assessment reveals flood, fire and burglary as potential risks, the appropriate remedial measures would be put in place to avert the occurrence or minimise their impact on the organisation.
Decision on how to handle each relevant risk effectively: It is a truism that generally, organisations stand a good chance of minimising their risk exposure if the risk is transferred to an insurance company. However, the effectiveness of this technique hinges on the evaluation of the cost of self-insuring and the cost of transferring the risk to an insurance company. If the cost of bearing the risk directly is higher than transferring it to an insurance company, it may be profitable to transfer, vice versa. Organisations can minimise risk by transferring activities that pose risk to another organisation. Suppose the management of a real estate company is gravely concerned about the potential liabilities emanating from maintenance on the 3rd and 4th floors of its chain of apartments throughout the ten regional capitals in Ghana. One way of eliminating this risk would be to contract with a construction company or maintenance company to carry out routine maintenance on the 3rd and 4th floors. Through this approach, the real estate company would transfer the risks to another company; it would heave a sigh of financial relief, and improve on its chances of profit maximisation. Viewed from a national perspective, the recent floods and fire outbreaks in certain parts of Ghana resulted in clarion calls on the Ghanaian Government to insure some state-owned assets. It is imperative for custodians of the state-owned assets targeted for insurance to carefully evaluate cost of self-insuring and cost of transferring the risk to an insurance firm. If the cost of insuring the state-owned assets through an insurance company may be high, relative to maintaining the assets and carrying out maintenance or reconstruction should the unexpected happen, it may be economically beneficial to opt out of any contractual arrangement with an insurance company. However, the reverse is true. Also, individuals who own or rent homes could purchase home or rent insurance if the insurance cost is low, relative to self-insuring.
Minimisation of the occurrence of unfavourable events: Efficient and effective risk management technique reduces the probability of occurrence of undesirable events. For instance, the probability that a flood would occur can be minimised or prevented through the construction of drainage systems, landfills, and land improvements that would provide adequate protection for organisations’ properties against flood. Provision of fire extinguishers at vantage points helps to minimise or prevent physical damages likely to be caused by fire outbreaks to corporate establishments.
Minimisation of the propensity of loss associated with unfavourable events: In our flood and fire examples, the total loss expected from the risks is the function of both the probability that the flood and fire would occur and the actual losses if the flood and fire occur. However, the monetary loss associated with the flood could be reduced significantly if stakeholders construct water passage, and strong defence walls that could withstand water pressure; or relocate their properties to areas that are not threatened by flood. In the same vein, the monetary loss that accompanies the fire could witness a significant reduction if stakeholders are prevailed upon to provide enough exit points and ventilation in their buildings, use the right electrical cables and engage the services of qualified and certified electricians in wiring their buildings; and to periodically engage the Fire Services Department in drills – education on fire safety, precaution and prevention. The Fire Service Department must intensify its efforts at fire prevention by not reneging in its responsibility of inspection, assessment and evaluation before issuing fire certificate to organisations especially, gas station operators across the length and breadth of the country.
Reduction in risk-generating activities: A firm that records constant negative returns on its investments in day-to-day operations and trading securities may decide to discontinue, and redirect its financial resources into areas that are more viable, productive and profitable. To illustrate, assume Mensean Company manufactures and sells two products, Product A and Product B. These products are not complements. That is, the demand for Product B is not dependent or contingent on the availability of Product A, vice versa. If the cost of producing Product B constantly exceeds the revenue generated, Mensean Company may decide to redirect the material and financial resources it invests in Product B to production of say, Product C, which the company believes would be more profitable than the former. Of course, venturing into Product C implies Mensean Company has conducted some amount of research, and it is convinced about the financial prospects and viability of Product C. In some cases, the company may simply channel all the resources of Product B into Product A to increase the volume of production of the latter while exploring other product opportunities.
In order to diversify its investment portfolio, Mensean Company may decide to invest in trading securities. Generally, a company may hold trading securities such as shares if it has no intention to become a substantive part-owner of the organisation or organisations from which the shares were purchased. Here, Mensean Company would carefully observe the securities market and trade or sell its securities when the securities market is characteristically bullish. That is, the company would sell when price per share and trading activities in the securities market are thriving. The strategy of an individual investor in the securities market may not be distinct from that of Mensean Company explained earlier.
Measuring the potential effects of a given risk: Another important function of the risk manager is to determine the magnitude of the identified risk or risks on the organisation: some risks could have strong negative impacts on the fortunes and survival of companies while the effect of others could be very minimal. If a firm is established in a geographically low-lying area, it is likely to be exposed to flood. The nature of the firm’s operations may also expose it to fire, burglary and occupational hazards such as human accident in the operation of factory machines. Classification of risks in this regard helps organisations to focus their attention on risks that are more threatening; and to prioritise their strategic measures accordingly. For example, should flood be identified as the most threatening, then the firm, through its risk manager, may take proactive steps to mitigate the effect of the flood on its operations and continuous existence as a corporate entity. The same applies to the other forms of risk mentioned in this section.
Purchasing derivative contracts to minimise risks: Firms can mitigate their strategic exposure to risk by using derivatives such as options, swaps, futures, and forwards. A commodity derivative allows organisations to minimise risks associated with the cost of inputs. Derivatives such as options, swaps, futures, and forwards are often employed by risk managers to ensure stability in their organisations’ cost of operations and stream of cash inflows. Individuals use derivatives to increase returns on their investments.
Although the writer emphasised on organisations as the unit of analysis, it is worth noting the various risk management techniques discussed in this write-up are pervasive, the techniques are applicable to risks saddled with nations and individuals alike. Therefore, it behooves key stakeholders and policy makers to carefully consider, identify and evaluate various forms of risk; and take proactive steps to stem their negative tide on the economy. An economy that is effectively armed against risk guarantees to a great extent, her chances of uninterrupted development and growth.
Ebenezer M. Ashley (PhD)
The Author is a Senior Consultant at Ghana Investment Services Centre,
Founder of Eben Consultancy,
Fellow and Council Member of the Institute of Certified Economists of Ghana (ICEG)